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No Sign of Excess = No Recession Fear: Households

Recent news of economic strength has sparked as much talk of recession as anything else. Strange as such a reaction might seem at first blush, those worrying point to two irrefutable facts: 1) Trump’s economic policy agenda seems to have stalled, and 2) the recovery has already gone on far longer than most.

Though it is hard to argue with either point, neither should they raise recessionary fears. To be sure, if Trump fails, especially with tax reform, it will disappoint market expectations and likely force a correction. But not every market correction leads to recession. For the economy, a Trump failure does no more harm than leave policy where it has remained the last 8-10 years, a drag on growth but nothing new and hardly a recessionary. Meanwhile those who count months and compare to the averages miss a critical point: recessions do not run on the calendar. Instead they occur in a response to excesses somewhere in the economy that beg correction. And this economy shows no such pre-recessionary excesses.

Certainly, American households, more than two-thirds of the economy, show nothing worrisome. Past recessions have often erupted because people had out spent their incomes, incurred excessive debts, and had to cut back. So far in this recovery, people have shown none of this behavior. On the contrary, they have shown remarkable prudence. They have kept their spending in line with income, and though the level of debt has grown, it remains manageable relative to income and household assets. Indeed, matters if anything suggest that households during this slow recovery households, rather than indulge in excess, have put themselves on firmer economic and financial footings.

People of course have increased levels of spending. They have, however, done so judiciously. Consumption levels have increased at a relatively cautious 3.4 percent a year during the past five years, for example, only very slightly faster than the 3.3 percent annual rate of income growth. The small difference has contributed to a modest decline in the rate of savings, which has fallen from about 5.0 percent of after tax-income five years ago to about 4.0 percent more recently (not the least because household tax liabilities have increased at a 4.1 percent annual rate during this time). But even today’s reduced savings flow is high by historic standards, suggesting that households face little immediate pressure to cut back.

Meanwhile the composition of income shows improved economic and financial health. Wages and salaries, for instance, have outpaced other sources of income, growing more than 3.5 percent a year during this time. Wages and salaries in the private sector have done even better, growing 3.8 percent a year. At the same time, reliance on government income support programs has lost significance. Income flows from unemployment insurance, for instance, have fallen almost 60 percent during this time.

Household finances have improved accordingly. To be sure, Federal Reserve (Fed) data shows a 2.1 percent yearly growth in household debt during this five-year stretch to levels of $15.2 trillion, long ago passing previous highs. But incomes have grown that much faster so that outstanding debt has fallen from 98.7 percent of annual income flows five years ago to 92.8 percent more recently. More telling are figures the relative burden of debt service. At last measure, the Fed calculates, households dedicate only some 10.0 percent of their after-tax income to interest and principal payments on all debts, down slightly from the about 10.5 percent registered five years ago and nowhere near the about 13 percent recorded just before the last financial crisis.

Generally accepted balance sheet analysis confirms this still-brightening picture. Against the relatively contained growth of household liabilities, Fed data shows a 4.1percent annual rate of expansion in the assets held by American households to $77.1 trillion. This is 5.1 times their current liabilities, a considerable improvement on the ratio of 4.7 times recorded five years ago. Accordingly, household net worth has increased a striking 4.7 percent a year during the last five years, to an outstanding amount of about $62 trillion.

Some might argue that these favorable comparisons are less secure than they seem. Much of the assets growth, they might point out, reflects stock market gains that could evanesce quickly should trouble emerge. Households then would have fewer assets but still face their entire debt obligation. Though there is no denying such arguments, it is noteworthy that households have also beefed up other more secure holdings. Bank accounts, money market shares, savings deposits, certificates of deposit, and the like, things that can provide secure sources of quick cash in an emergency, have risen faster than debt, going from 7.3 percent of all household liabilities five years ago to 10.4 percent more recently. Though this amounts to nothing near large enough to handle all the debt (which would be unprecedented) what matters is that secure assets provide a much bigger cushion than previously.

For those want to worry, or who want to sow fear, nothing is ever safe enough. But apart from such understandably human inclinations, everything in the household sector — in overall terms, in the composition of its income sources, and in its finances — points to improved health and an ability to support spending and the economy going forward. The same can be said about the corporate sector. More on that in a coming article.